United States: Professor’s art career was business - not "hobby" - for tax purposes

Earlier this month, the United States Tax Court held that the work of a visual artist - who was a full-time art professor - constituted a business, not a hobby, for purposes of the tax law. Result: the artist, who had incurred losses from art sales, was allowed to deduct the expenses of her art business on her income tax returns. It's a reassuring decision for artists who earn steady incomes from teaching or other occupations while pursuing their careers as artists. Here's a summary of the case.

The Decision

The case involves a visual artist who is also a tenured professor of studio art. For more than 40 years, she has sold her works through at least five New York galleries, and her work hangs in the permanent collections of at least 25 museums, including the Metropolitan Museum of Art and the Guggenheim Museum. Her works reside in corporate collections, and she has received numerous residencies from art organizations. According to the court, the artist sold a total of 356 works from 1971-2013, generating approximately $668,000 in net income (averaging just under $16,000 per year), after subtracting gallery commissions from the gross sales proceeds.

The IRS claimed the artist/petitioner underpaid her taxes by approximately $81,000. Like many artists, she had claimed deductions for expenses such as supplies, travel, meals and research. The IRS argued that the artist's work was "an activity not engaged in for profit" (i.e., a hobby), and therefore she was not entitled to claim deductions in excess of the income she derived from that activity. Alternatively, the IRS argued that, if petitioner was engaged in a business during these years, many of her claimed deductions were not "ordinary and necessary expenses" incurred in carrying on that business.

At the close of trial, the Tax Court bifurcated the case so that those two issues would be decided separately.

On the "hobby" issue, the Tax Court ruled that the petitioner was engaged in a "trade or business" with the objective of making a profit from her activity as an artist. (The court left the substantiation of her expenses, the character of those expenses as "ordinary and necessary" and her liability for penalties for another day.) While the court found that, ordinarily, the fact that a taxpayer incurs a series of losses beyond the startup years may imply the absence of a profit objective, "because it often takes years to achieve economic success in the creative arts, [the Tax Court] has found that a 'history of losses is less persuasive in the art field than it might be in other fields.'" The court ruled that, even though petitioner had reported losses for 18 of the last 20 years, she had nonetheless demonstrated an actual and honest objective of making a profit from her artwork.

Take-away Message

This case is seen by many as a win for creative artists, who rely on the ability to claim tax deductions for expenses incurred in their work as artists. As long as the artist is able to show that she has an actual and honest objective of making a profit, the expenses incurred in making art may, depending on all the facts and circumstances, be treated as business expenses for purposes of the tax law. We note, however, that business deductions in any context are subject to scrutiny by the IRS, and may be disallowed where they are not "ordinary or necessary" or where the expenses are essentially personal in nature.

WHY REGISTER WITH SAIT?

Section 240A of the Tax Administration Act, 2011 (as amended) requires that all tax practitioners register with a recognized controlling body before 1 July 2013. It is a criminal offense to not register with both a recognized controlling body and SARS.